The measure plunged 6.7 percent to 2,667.75 yesterday, the most since June 2008, and entered a bear market on concern a slower lending growth may derail a rebound in the worldâs third- largest economy. Xie said the index âshould be 2000 or less.â

âThe market is in deep bubble territory,â Xie, 49, who correctly predicted in April 2007 that Chinaâs equities would tumble, said in an interview with Bloomberg Television.

Chinaâs retreat sent the MSCI World Index of 23 developed nations down 0.8 percent, while MSCIâs emerging-market index lost 1.5 percent, the biggest drop in two weeks. The Bank of New York Mellon China ADR Index, tracking American depositary receipts of Chinese shares, lost 2.3 percent, led by commodity producers.

The Shanghai gauge slumped 22 percent in August, the biggest decline among 89 benchmark indexes tracked by Bloomberg, as banks reined in lending to avert asset bubbles and policy makers advised industries such as steel and cement to curb overcapacity. The decline stopped a rally that had sent the measure up 103 percent from a November low on prospects the governmentâs 4 trillion yuan ($586 billion) stimulus program and a record amount of new credit would ensure the economy grows at least 8 percent this year.

Strong Numbers

âThe local market bears are convinced that tightening is already underway,â said Howard Wang, head of the Greater China team at JF Asset Management, which oversees $50 billion. Only âa very strong set of macro numbers in Augustâ or âstronger statements from central authoritiesâ would change this trend, Wang said.

Still, Chinese stocks are trading at the steepest discount in the world compared with analystsâ price targets after the month-long slump. The gap of 13 percent below analystsâ combined price targets is the largest among the worldâs 10 largest markets, data compiled by Bloomberg show.

Equities in China remain âa bright spotâ among global stocks because of the nationâs strong growth potential, Goldman Sachs Group Inc. said yesterday.

âExit Strategyâ

âWe think the market concerns about a near-term âexit strategyâ appear premature as the government remains pro- growth,â Thomas Deng and Kinger Lau, analysts at Goldman Sachs, wrote in a research note.

Goldman Sachs has boosted its growth forecasts for Chinaâs economy to 9.4 percent this year from an earlier estimate of 8.3 percent, it said in the note. Gross domestic product may increase 11.9 percent in 2010, higher than an earlier estimate of 10.9 percent, it added.

The Peopleâs Bank of China will also have âvery limited roomâ to raise interest rates by the end of this year, Deng and Lau wrote.

âThe A share market is undergoing a correction rather than a bursting of the bubble,â said Richard Gao, who helps manage $2.8 billion at Matthews International Capital Management LCC in San Francisco. âShort term trading will be very volatile but we believe a strong economic recovery is underway in China and remain quite positive on the long-term growth potential.â

The government will maintain its fiscal and monetary policies because the economy faces many âuncertainties,â Premier Wen Jiabao said this month. Economic growth will slow in the fourth quarter as exports remain mired in a slump, Xie said.

âThe recovery is not sustainable,â Xie, who resigned as Morgan Stanleyâs chief economist in Asia in 2006 and now works as an independent economist, said in the interview yesterday from Shanghai.

Expectations

âThis is a short-term negative,â said E. William Stone, who oversees $101 billion as chief investment strategist at PNC Wealth Management in Philadelphia. âExpectations have been too high that China would be a driver of everything. Much has to come out of the expectations balloon.â

At least 150 stocks on the 898-member Shanghai index dropped by the daily 10 percent limit. Industrial Bank Co. and Aluminum Corp. of China Ltd. tumbled by the permitted cap after Caijing magazine reported new loan growth this month may be almost half that of July. Lower profits dragged Baoshan Iron & Steel Co., the nationâs biggest steelmaker, and China Southern Airlines Co. down at least 7 percent.

The Shanghai index trades at 29.39 times reported earnings, according to Bloomberg data. The MSCI Emerging Markets Index, a 22-country benchmark, trades for 18.9 times profit.

New Loans Drop

China may have 200 billion yuan of new loans in August, the Beijing-based Caijing reported today on its Web site. That compares with 7.4 trillion yuan for the first half of 2009 and 355.9 billion yuan in July alone. The government plans to tighten capital requirements for financial institutions, three people familiar with the matter said this month.

An estimated 1.16 trillion yuan of loans were invested in stocks in the first five months of this year, China Business News reported June 29, citing Wei Jianing, a deputy director at the Development and Research Center under the State Council.

âThe government is now pulling the plug on liquidity,â said Xie, who is a guest columnist for Caijing. âHopefully, itâs not too late.â